EP8: How to Increase the Valuation of Your Consumer Product Company | Mark Dufilho, Managing Director, Houlihan Lokey’s Inc.
EP8: How to Increase the Valuation of Your Consumer Product Company | Mark Dufilho, Managing Director, Houlihan Lokey’s Inc.
https://open.spotify.com/episode/6Cc2ZdUvmgI3MoGMFAnsyV What you’ll learn: We had a fascinating conversation with Mark Dufilho on how a business owners of consumer product brands can raise their evaluations pre-sale. He leads us through a crash course on how to bring a consumer brand to market and achieve liquidity for their business in the wake of China tariffs. About our guest: Mark Dufilho is a Managing Director in Houlihan Lokey’s Dallas office, where he is a senior member of the Consumer, Food & Retail Group. He has nearly two decades of experience providing transaction advisory and corporate finance services to small and mid-cap public and private companies and private equity firms across several branded consumer products segments, including branded apparel, consumer electronics, health & beauty, household & home products and retail. Dufilho graduated summa cum laude with B.B.A.s in finance and international business from Loyola University, and he holds an M.B.A. from Harvard Business School. Advisory and full service for MMA for middle market and private companies. Go to market “bankers only specialize in technology.” Focus only on consumer products… Help sellers achieve liquidity for their business Key takeaways from this episode: Background story of Houlihan Lokey, Inc. – 3:18 Biggest mistake business owners make when thinking about EBITDA multiples – 4:43 The true way to determine the value of your business – 5:00 General Breakdown of an EBITDA and a multiple – 5:11 The different types of investors and the types of return they expect – 7:07 How tariffs are impacting an investors evaluation of your company – 8:31 Are tariffs an appropriate Addback? – 10:26 Should you still take your company to market? – 11:27 How consumer product brands should approach buyer options – 13:00 Future analysis of our marketplace – 15:18 Which sales channel should you focus on to drive up your evaluation – 16:10 The benefits of building an ecommerce sales portfolio with big box retailers – 21:39 The most important 3 threes to focus on for a higher evaluation pre-sale – 23:34 Podcast Transcription Speaker 1: Welcome to the Page 1 Podcast. A twice weekly podcast featuring a variety of guests and thought leaders on topics ranging from channel strategies to tariffs, influencer marketing, best-in-class product launches, and all the details about how to accelerate your eCommerce sales with the big box retailers, or what we call rCommerce. Now here's your host, Luke Peters. Luke Peters: Thanks again for joining us on the Page 1 Podcast. I'm your host, Luke Peters. This is the podcast where I bring you the best and brightest leaders in consumer product industry that will help you grow your products, launch new skus, and grow in the big box retailers like Home Depot, Lowe's, Wayfair, and all of those other retailers that we call rCommerce. I'm the CEO and founder of NewAir Appliances where I cut my teeth for the last 17 years selling products online, and I've started a retail band where we can help other companies learn how to launch products, use influencer marketing to launch products, get reviews, gain traction, sell into Home Depot, Wayfair, Lowe's, Target, Amazon, and all those other sites. Luke Peters: And today I am interviewing Mark Dufilho who's the Managing Director of Houlihan Lokey. Mark graduated summa cum laude with BBAs in Finance International Business from Loyola University and he holds an MBA from Harvard, and I have met Mark in-person, he's literally one of the smartest guys that I've met. And thanks for coming on the show, Mark. Mark Dufilho: Oh, it's my pleasure. Thanks for having me. Luke Peters: Awesome. And anything else that I might've missed in your background that might be important for the listeners to know about? Mark Dufilho: No, you were certainly complete from an educational perspective, seems quite a long time ago now. Luke Peters: Yeah, I know, it's impressive though. And like I said, I had the opportunity to meet with Mark for about an hour a couple months ago. Learned quite a bit about how to think about my company, NewAir and how to position ourselves correctly. And so I thought that it's really a special treat for you guys, our listeners, who's mostly comprised of consumer product brands to kind of learn and get educated from Mark on how to think about correctly growing your business and positioning your business. Luke Peters: So today I got a bunch of questions related to preparing the company and I guess before we get started, I was just talking to Mark about this, again, what's interesting is you're in charge of the consumer products side of Houlihan Lokey, which is a huge firm, the biggest right, in certain deal sizes. You guys are like the number one deal firm? Mark Dufilho: Yeah. As far as the middle market goes, which is certainly deals below $1 billion in value, we execute on more than anybody else in the country, and actually within consumer products, irrespective of the deal size, our team handles more deals or M&A deals every year than any other bank in the country. Luke Peters: Yeah, which is incredible. And also the fact that... Like you said, that's your area of expertise and that fits perfectly into this podcast. So now that we've kind of worked through that part of it, why don't we start with something obvious, which I think a lot of the listeners might know. But if you can kind of give us a general breakdown of how multiples are reached from an investor perspective, whether that's a PE group or another firm that's trying to roll up similar companies besides just EBITDA, what are the types of things that might fall into that? Mark Dufilho: Sure, happy to. And maybe just to give your listeners a sense of perspective of where my experience or thought process is coming from. Our firm is a full-service investment bank, but all of what we do is advisory services, and within that most of it is in and around M&A and financing for middle-markets and private companies. And we go to market and deliver these services on an industry-specific way. So we have bankers that specialize only in aerospace and defense or technology or other industrial industries. Our team, which is about 70 bankers across the country and Europe are focused only on consumer products, in every sector of consumer. Whether it's food and beverage, pet, health and beauty, home products, retail, restaurants, et cetera. Mark Dufilho: And literally, what we think about day-in and day-out is the question you asked, which is EBITDA multiples and valuation. Because the vast majority of what we do is help sellers achieve liquidity for their business. EBITDA and EBITDA multiples is always an interesting topic of discussion. And what I found is the biggest mistake people make in thinking about that is that it's simple math. If I maximize my EBITDA and I'm maximize my multiple, I'll maximize my value. Well, there's truth to that, but the real truth is value is determined by looking at what the longterm, sustainable cashflow of the business is, and value has always been determined that way. Mark Dufilho: EBITDA and multiples are a simplifying language for people to very quickly try and ascertain value for a company, a group of companies or an industry, and then use that basis of comparison across those companies and understand why one business may trade at a higher multiple than another. What the multiple comes from is someone's belief in the sustainability and defensibility of that EBITDA and then the growth opportunity inherent in that EBITDA over a three to five to seven year period over time. And then the third piece, if it is a financial investor and the idea is to eventually sell that business again, whether they believe that EBITDA multiple can be sustained three to five to seven years in the future or will that multiple contract or expand over time based on the growth opportunities for the business. Luke Peters: Yeah, and that's a great explanation. And I was taking notes here and I wrote down, actually what I think might be the key point you can tell me, but value is determined by the longterm cashflow. And I've heard and read that a lot of investors, a lot of it is all about risk, more risk equals you're going to get lower multiples, lower returns, and more risk. And less risk is what investors are looking for. And that would feed into the longterm cashflow model, right? Mark Dufilho: That's exactly right. Every evaluation is an element or combination of the required rate of return and a cost of capital. Parlay it against what people expect those future cash flows to be. Which is why when people talk about debt multiples and leverage, and the higher the leverage, the higher the value. There is truth to that because what that means is that investor is able to replace higher cost of capital investments, the equity component, with a lower cost of capital, a debt component, thereby allowing them to pay more. Luke Peters: Makes sense. And is there a certain return on capital that they also calculate in the bank? That factors into whatever the multiple ends up being, because they're going to have to usually leveraging these companies up quite a bit or is that not- Mark Dufilho: Sure that is a cost that an investor is looking for? Luke Peters: Correct. Mark Dufilho: Yes. It depends on the type of investment that you're making. A venture-based investor is going to be looking for a significant return of capital and that tends to be a very high percentage return, 35%-type return, because they're trying to make multiples of their money because it's a much riskier investment, it's an earlier-stage company, it's an unproven concept, whatever the case may be. A more mature investor that's making investments, a traditional LBO or private equity firm, that's making investments in established and more mature companies is going to look for a lower return, because the lower risks that they're taking. Traditionally, they looked for 20%-22% returns. In today's market, you'll see that number down as low as 16% returns, right above where you start to see junior debt capital start to look for returns. So think of the stack as senior debt, maybe looking for 5%-6%, junior debt or second-lien debt, maybe looking for 8%-12%, and then equity starts to look for 15% on up. Luke Peters: Okay, awesome. And that's super valuable. Those middle investors, that would be also termed as, mezzanine debt, is that another term for it? Mark Dufilho: Correct. Luke Peters: Okay. And then something really specific just because of the world we live in with tariffs. Some specific questions related to that. Just because everybody that's listening here is probably in the consumer products, everybody's going to be affected by tariffs or not everybody, but most everybody. And when investors now... What they're having to look at isn't what they had to look at a year ago. So now we have tariffs involved, which could be driving down net profit. Luke Peters: So a couple of questions. Do you think tariffs could be, should be, will be, introduced as an add-back? Is that a legitimate add-back, especially if they go away in the future. But even if right now, would that be an add-back? And number two, how would those, could they negatively affect an investor's opinion because they're adding in some friction and some uncertainty? Mark Dufilho: Sure. So I'll take that in reverse order. Tariffs are absolutely a point of disruption in the market today. They're disrupting people's businesses and supply chains and pricing models and margin structures, no doubt, but they're severely disrupting the M&A environment, because there's so much uncertainty that they interject. If you're a private owner and a seller of a business today, and you fundamentally believe that these tariffs are a temporary cost, you're going to argue that a buyer should look past those and look at a more normalized view of profitability and assume those will go away. However, if you're a buyer, you've got to be thoughtful about what that tariff, how long the tariff regime can stay in place, whether it can get worse, and what it means with respect to a short-term versus a longer-term disruption of business. Mark Dufilho: And so what we're finding at the end of the day is buyers are placing a discount on value to accommodate either tariff costs or tariff uncertainty on a go-forward and sellers have been less willing to accept that discount. They're more willing to hold on to businesses and not sell at this point in time. We've not advised clients to try and add back the cost of tariffs. We don't think that the sophisticated investor market is accepting that, simply because there is uncertainty around how long they will remain. We are, however, advising clients to add back some of the truly temporary costs that have come because of it, whether it's a cost from excess warehousing or inventory carrying costs because a company bought ahead of a potential tariff impact, or if it's the resolve of the cost of moving a supply chain out of China into a non-tariff country. Those are temporary and one-time in nature and we believe those are appropriate add-backs. But there's far too much uncertainty around tariffs today. Just sort of wave a magic wand and say, assume those costs aren't there because we don't think they'll be there forever. Luke Peters: So and since the impact is so huge on first, a lot of companies... Especially in the 25% sector, does that mean or do you have an opinion on if companies should maybe wait it? Out because if they truly aren't add-backs and all things being equal, that's going to really hurt a net profit number or a multiple. Do you think most companies would be advised to wait it out or is it really going to be deal-by-deal and kind of up to the specific buyer? Mark Dufilho: Great question. We're generally advising clients if they material impact from tariffs to wait it out. Unless there is another reason why it makes good sense to look to drive liquidity today, and there's any number of reasons why that may make sense, be it personal dynamics, family dynamics, shareholder dynamics, other company dynamics underway. All things equal, were advising people to hold off on taking a business to market if there is material tariff impact on their business because buyers are placing a discount against that. And I have a personal belief that the tariff situation will get resolved. However, I think we're still looking at measuring time in terms of quarters and possible years, not months. Luke Peters: Yeah. And that was going to be my next question. And I was really optimistic at the beginning and now, I got to put my head down and we just have to run the business and plan like they're going to be here forever. And if they're not then everything's even better, right? Because a bunch of improvements will have been made by that point. But hopefully, for everybody they get resolved. Okay, great. Luke Peters: Why don't we move on to another... I know this is on a lot of people's minds and probably something that you talk about all the time, but let's talk about the, if you can kind of quickly describe how consumer product brands should be thinking about either working with a financial buyer, which is like a PE firm, right? Or a strategic buyer which might be another bigger brand. What are the different options they should be weighing when they consider those choices? Mark Dufilho: Sure. A lot of it comes down to where company and the seller is, in their personal cycle and ambitions as well as where the company is in its life cycle. There's sort of a general thought process that has held true generally by and large that a strategic buyer because of the strategic and synergy value that can be achieved in a deal is going to pay more than a financial buyer for a company. That thinking has actually been flipped on a ted a little bit. It certainly in certain consumer segments in the last couple of years as the private equity market has gotten more and more competitive and there's more money available and you've seen valuations go up. Mark Dufilho: What people have found is that, if they are at a place in their life cycle, in their company life cycle where they're not quite ready yet to move on to the next project and they believe there is material upside in their business, they can actually maximize their longterm value creation by selling to a private equity fund today, selling a minority stake, selling a majority stake and holding onto a meaningful part of the business, growing that business, using the assistance in partnership with a private equity fund and then eventually selling it. Again, this is the proverbial second bite of the apple and finding that that's far more value creative than simply selling 100% or something close that to a strategic buyer today. Mark Dufilho: The flip side is, there are certain categories out there, be it certain branded snack and branded food categories, beverage, health and beauty where the strategic buyer appetite given some significant trends that are taking place with their core brands in the market. Strategic buyers are paying extremely high multiples for businesses that in some cases are still fairly small brands. So we do see that as an opportunity to take advantage of what's happening to those strategic players and really capture some of that value early. But overall I'd say it comes down to the company's specific situation and and what their real goals and ambitions are. Luke Peters: Great. And also I'm kind of on that point in how buyers are looking to companies and given the recent drop or the cost of capital is getting cheaper, right? With the recent FED moves and also expected additional cuts, is that going to, you think push or drive the market higher even now that the rates might come down further and the lending might be cheaper or does it not have that much of an effect? Mark Dufilho: So all things equal, it certainly has an effect that if the cost of capital goes down, values go up. The flip side of that is one of the reasons that the cost of capital may come down. So rate decreases is growth is slowing and there's more uncertainty in the economic and the consumer environment. And so any value increase you may see mathematically from that is likely going to be offset or more than offset by a lower outlook for growth going forward. Luke Peters: Yep, makes sense. Okay. And now let's talk about channels and how much those... And before I get into the question, there's been a lot of talk or at least conversations I've had or with friends and stuff about how driving the volume and value of direct to consumer channel within a company is really important because that portion of the company will get a higher multiple than say an in store portion. Investors are more excited about the consumer or the brand owning that direct connection and sale to the consumer and being able to not have to rely on the big box stores 100%. So the question around this is, if you look at three different revenue streams... And first of all, does this even matter? But the question is around three different revenue streams. Maybe a company is selling into Amazon, maybe they're selling in-store and then maybe they're selling direct to consumer on their website. Should that brand owner be focusing on growing that direct to consumer channel even bigger just for the sole purpose that he or she might get a bigger multiple upon exit. Mark Dufilho: Sure. There's a lot to unpack there. I'll try and take it sort of one step at a time and do it efficiently. Luke Peters: Sure. Mark Dufilho: Channel absolutely matters. There's no question about that. Whether you are selling to a general merchandiser, whether you're selling to the grocery channel, whether you're selling to a specialty retail, whether you're selling to Amazon or...